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Important changes to regulations and compliance for investment funds

This update highlights key changes to the regulatory and compliance regime for Cayman investment funds in 2018.

The changes that have been made to the anti-money laundering regime will bring the Cayman Islands into line with international best practice and are a welcome update to the territory's financial services landscape. In reality, the changes will not affect the majority of investment funds using the jurisdiction, but updates to documentation and procedures may be required.

In practice, unregulated funds will achieve anti-money laundering compliance in much the same way as funds regulated by the Mutual Funds Law – namely, by delegating these functions to a service provider, such as a regulated administrator or investment manager.

The simplest option will be to delegate to an administrator or investment manager that is regulated for anti-money laundering purposes in a recognised jurisdiction with equivalent standards to the Anti-money Laundering Regulations (eg, the Cayman Islands, Ireland or Bermuda). In such cases, the delegate's compliance with its jurisdiction's regulations will be sufficient to ensure that the Cayman-based fund complies with its obligations.

However, US and Hong Kong-based fund administrators are not generally regulated in the United States or Hong Kong and are subject to only general anti-money laundering legislation in those jurisdictions. As such, delegation to US or Hong Kong-based administrators will be subject to confirmation that they will provide services in accordance with the Proceeds of Crime Law and the Anti-money Laundering Regulations. Alternatively, the directors or general partner of the fund must confirm that the standards adopted are equivalent to the Cayman anti-money laundering regime. In these circumstances, a compliance officer and money laundering reporting officer (and deputy) must also be appointed by the fund.

For most funds, this change should not present a significant problem as many fund administration agreements will anticipate that the administrator will report suspicious activities in accordance with its own regulatory obligations.

However, all funds should review their administration or delegation agreements to ensure that this is explicitly dealt with.

For funds that must appoint a money laundering reporting officer and deputy money laundering reporting officer, these are management-level roles with substantial responsibilities, including:

assessing reports of suspicious activity in relation to money laundering or terrorist financing; and

determining whether to report such suspicious activity to the Financial Reporting Authority.

Where the fund does not have its own employees (which will be the case for most funds), the Guidance Notes detail the criteria that should be applied in selecting an appropriate person to fill each role and guidance on the delegation and outsourcing decision-making process.

Subscription payments from bank accounts in regulated jurisdictions

Until the adoption of the new regime, funds and their administrators were not obliged to obtain full know your customer (KYC) documentation from investors whose accounts were held in their name at a bank regulated in an equivalent anti-money laundering jurisdiction, on the basis that the appropriate due diligence had been taken by the bank.

As part of the overarching risk-based approach that is now key to the anti-money laundering regime, the regulations require that before the fund receives subscription monies from an investor's account held at a regulated bank, the fund (or its delegate) must have:

assessed the level of risk relating to the investor (ie, low, medium or high) and identified the risk as low; and

identified the customer and its beneficial owner, and assessed whether full KYC documentation or further information is required.

In reality, few fund administrators relied on the previous exemption and obtained full KYC documentation from all investors regardless. Where that has not been the case, the practical consequence will be that some investors in Cayman funds will need to provide full KYC documentation in more situations than before.

Administrative fines

On December 15 2017 amendments to the Monetary Authority Law and associated regulations came into force, increasing CIMA's powers to impose administrative fines for breaches of certain regulatory laws. These fines can initially be imposed for breaches of the Anti-money Laundering Regulations, with a maximum fine of up to CI$1 million (approximately US$1.22 million).

CIMA must classify breaches as minor, serious or very serious, and will apply these criteria when it exercises its discretion to impose fines. The minimum fine for a minor breach is CI$5,000 (US$6,098).

Once further regulations under the Monetary Authority Law are adopted, CIMA is expected to use its new powers to increase action for breaches of all regulatory laws, including the Mutual Funds Law and the Securities Investment Business Law (eg, for failure to make filings within time limits without applying for exemptions or extensions).

New tax offence

Changes to the Penal Code (the law which contains most criminal offences in the Cayman Islands) mean that a new criminal tax offence has been introduced into Cayman law. This may seem odd in a jurisdiction with no direct taxation; however, a direct consequence of the new offence is to require reporting of suspicion of overseas tax evasion as part of the anti-money laundering framework.

It is now a criminal offence for a person with intent to defraud the government to wilfully:

make or deliver false or fraudulent information, or cause false or fraudulent information to be made, to a person employed in the public service relating to the collection of money for the purposes of general revenue;

omit information that must be provided to a person employed in the public service relating to the collection of money for the purposes of general revenue; or

obstruct, hinder, intimidate or resist a person employed in the public service in the collection of money for the purposes of general revenue.(1)

With no specific punishment provided, the offence will be punishable by four years' imprisonment and a fine (not an insignificant deterrent).

However, the main offence of tax evasion will likely be of limited applicability given the lack of direct taxation in the Cayman Islands.

The real effect of the new offence is as part of the anti-money laundering framework, as overseas tax evasion now constitutes criminal conduct and the proceeds of such conduct are the proceeds of crime. The Proceeds of Crime Law requires dual criminality for offences that are committed outside the Cayman Islands in that the conduct must be an offence not only in the place where it was committed (if not the Cayman Islands), but also in the Cayman Islands in order for it to constitute criminal conduct.

Failure to make the required disclosure when a party knows or suspects, or has reasonable grounds for knowing or suspecting, that another party is engaged in criminal conduct (eg, tax evasion overseas) – in the absence of any defence – is punishable by imprisonment, a fine or both.